Danger Lurks When Shopping for Student Loans

When college financial aid officers got into trouble last year for accepting gifts from lenders, the moral of the story was clear: You could easily overpay for your student loan by simply borrowing from a college’s recommended lender without first shopping around.

There is just one problem with comparison shopping for a private student loan. Doing so may damage your credit score. Since lenders quote higher interest rates to applicants with lower scores, some students could end up paying thousands of dollars more in interest over the life of their loans.

In few other areas of consumer life are you at risk of being penalized for seeking out the best deal. Indeed, mortgage and auto loan seekers who comparison shop within a relatively short period of time do not see their credit scores suffer. But Fair Isaac, the company that helps credit bureaus calculate credit scores, does not extend the same break to private student loan applicants or their parents, who often co-sign for loans.

The basic inequity here — the fact that people borrowing money for higher education are not given the same benefit of the doubt as people shopping for mansions and BMWs — is unfortunate enough. But the real head-scratcher is how little anyone in the industry seems to know about how often students and their parents suffer damage. Fair Isaac thinks it’s rare, if it happens at all. Lenders and student loan brokers think it’s common.

The disagreement wouldn’t matter if Fair Isaac bowed to the will of the New York State attorney general’s office. The office has been investigating the student loan industry for more than a year and has asked Fair Isaac to treat student loan borrowers like car and home shoppers. So far, Fair Isaac has refused to change its policy.

This issue matters because even a small credit score decline can lead to a more costly interest rate. Every point counts at a time of tightening credit standards, when many lenders have been requiring higher minimum credit scores. In addition, banks have been getting stingier with another source that parents tap for tuition money, home equity loans.

How did it come to pass that 18-year-olds were vulnerable to paying more because they shopped around? To answer that question, and develop strategies for credit score damage control, you need to know a bit more about the worlds of student debt and credit score algorithms.

Borrowers took out $17.1 billion in private sector loans in the 2006-7 school year, according to preliminary College Board figures. Part of what makes private loans different from other student loans is that rates can range wildly, by several percentage points, even with one lender.

To quote a rate, lenders check an applicant’s credit history. And every time a shopper asks a lender for a rate quote, it can show up as another inquiry on a credit report.

Lots of inquiries send the wrong signals to the formulas that create the popular FICO credit score that Fair Isaac administers, namely that borrowers may be applying for multiple loans because they’re financially troubled and potentially going bankrupt.

While Fair Isaac has mined years of data to determine that people making a bunch of mortgage and auto loan applications over a short period are almost always innocently shopping for a loan, it hasn’t declared student loan shoppers similarly safe.

One reason is that the company doesn’t have a big pile of private student loan data to mine. These loans are relatively new, and not many people shopped around for the best rate before the student loan scandals erupted.

So, in theory, how much could credit scores fall when people shop for loans? Fair Isaac says that each inquiry will generally not cause more than a five-point drop, though it may be more for a student with a short credit history.

Lenders generally check credit reports with only one of the three main credit bureaus. If a lender examines only one such report, an applicant avoids damage on the other two bureaus’ records. Then again, if all the lenders check with the same credit bureau, the damage may be especially high there.

Here’s Fair Isaac’s problem with this whole discussion: It doesn’t believe that any damage occurs most of the time. It believes that the three big credit bureaus don’t classify most student lenders specifically enough for the credit scoring system to recognize them. As a result, those inquiries end up in a general category that gets the same treatment as auto and mortgage inquiries.

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Equifax confirms that it does not specifically classify credit requests from student loan lenders, though a process to do so is in the works. According to Experian, a small drop in a credit score is possible, and whether it happens depends on the type of classification the lender uses. Transunion declined to comment on how its systems mingle with Fair Isaac’s equations.

Frederic Huynh, principal scientist for Fair Isaac, said the company has talked to a handful of lenders about this issue and hasn’t found any who say that applicants have experienced credit score drops. How many? “Probably less than five,” he said. He declined to name them, citing confidentiality.

Sallie Mae, which believes it is the largest private student loan lender, is convinced that there can be an impact. “We do see it,” said Tom Joyce, a company spokesman, who added that Sallie Mae, like the New York attorney general, wants Fair Isaac to treat student loan borrowers like car or home borrowers. “We don’t think consumers should be penalized for shopping.”

Meanwhile, Fair Isaac’s explanation came as a huge surprise to Marc Stein, who’s been trying for two years to build an online student loan brokerage firm that would allow people to shop for many loans at once without damaging their credit. He’s gone so far as to help create a new type of credit check that doesn’t damage an applicant’s credit score, a move that required approval from Fair Isaac and others in the credit reporting industry.

“I’ve never had them tell me, ‘Oh, you’re not addressing a real problem,’ ” said Mr. Stein, who’s the chief executive of Student Loan Monkey.

The fact that nobody knows the extent of the problem is a pathetic state of affairs, given the potential impact on people just getting started in life. And the solution seems pretty simple: Fair Isaac ought to simply give 18-year-olds and their parents the same break it grants shoppers for cars and homes.

Fair Isaac says it prefers not to make a move like this without data to back it up. That’s fine, but it’s sure going to be hard to get it if the credit bureaus can’t identify the requests for credit data that come from student lenders. Even if Fair Isaac can get good data, however, Luke Swarthout, higher education associate for the consumer advocacy group U.S. PIRG, says Fair Isaac need not to wait years for it to pile up.

“It’s an analytical crutch for them to say that we need to see the data,” he said. “There really is only one plausible explanation for a student receiving multiple requests in a short period of time, and that’s because a student is shopping around.”

In the meantime, lenders could help a lot by doing the following: First, state on their Web sites which credit bureau or bureaus they are using. Then, state whether that credit bureau is classifying their requests in a way that could damage an applicant’s credit score.

Meanwhile, some shopping around still makes sense. You’ll probably do best by comparing three or four lenders and finding the lowest rate — even if your credit takes a small hit in the process.

Start with a lender or two that your college recommends, since it may have negotiated special terms with them. Mark Kantrowitz, who runs the comprehensive college financing site, finaid.org, suggests shopping one bank, one finance company that specializes in student loans and then looking for nonprofit loan agencies that work with people in the state where you live or the state where you attend college (or both, if you’re lucky enough to have a choice). Mr. Kantrowitz has a list of such lenders on his site (I’ve linked to it from the online version of this column at nytimes.com/yourmoney, where there’s also a link to a New York Times Topics Page on student loans), or you can ask people in the financial aid office whether a nonprofit lender serves the college.

As you shop, however, keep one other thing in mind: Fair Isaac believes that if there is any credit score impact on applicants’ credit scores, it’s more likely to occur when people apply to smaller or specialized student loan lenders. Big banks, apparently, are less vulnerable. This will probably not make the scrappy upstarts happy, but they know who they can complain to.

Finally, do all of your shopping within a week or two. Right now, there’s no sure way to know ahead of time whether the lenders to which you’re applying are ones that get a free pass in Fair Isaac’s system. If they do, however, you may lose the benefit of the exception by taking months to find a loan.

What happened to your credit when you applied for a student loan? E-mail: rlieber@nytimes.com.